Nepotism and Good Management Do Not Combine – or Do They?

Here is a piece of conventional wisdom that I and many others firmly believe: Nepotism is the enemy of good management because it places untested and often unqualified people in important positions simply because of who their parents are. Most of us do not work in organizations owned and controlled by families, and even some of us who do are working in organizations owned by families but controlled by professional managers who have been carefully selected. Then there is the rest of us, who worry about the capabilities of the owner family child in an executive role, and who have read the news about scandals such as the Samsung family ownership.

But every now and then some evidence appears that gives us reason to rethink our beliefs. In a paper published in Strategic Management Journal, Guoli Chen, Raveendra Chittoor, and Balagopal Vissa look at CEO pay in family firms in India, comparing those run by CEOs from the family versus those run by non-family CEOs. Their findings contained some surprises.

Here is an unsurprising finding: CEOs from the family get paid more. Sure, we all know about favoritism and about extracting resources from a firm (which also has non-family owners) to put into the family’s pockets. This is an annoying finding, but it is no surprise. Oh and by the way, the increase in pay depending on the firm performance is nearly the same for low and high performance provided the CEO is a family member, but a nonfamily CEO does not benefit from higher performance.

Here is a surprising finding: When they checked the data more carefully, they found that the family CEOs actually got rewarded very much when the firm had very high performance, less so when it had average or low performance. This is exactly how one would design an incentive scheme for CEOs, because disproportionate rewards at the high end are necessary to compensate for their reluctance to take risk. But why is the incentive scheme especially well designed for family member CEOs?

One more interesting surprise that might be telling: The relation between high performance and higher pay is particularly strong if the firm is named after the family. So, exactly the kind of firm that would embarrass the family if the performance were low has a family CEO with good incentive pay. Interesting way for the family to control their (younger) CEO member, right?

You have probably read through this and concluded that it does not matter. Having a good incentive scheme is not the same as getting high performance. After all, poorly qualified spoiled brats are not going to accomplish much regardless of how they are rewarded. True, except for one thing. The firms managed by family CEOs had higher performance on average than those managed by nonfamily CEOs. This is certainly a paper to make us reconsider our beliefs.

Chen, G.,R. Chittoor, B. Vissa. 2021. Does nepotism run in the family? CEO pay and pay-performance sensitivity in Indian family firms. Strategic Management Journal 42(7) 1326-1343.